HMRC v Smith & Nephew (2020)


Michael Gibbon QC (leading James Rivett QC of Pump Court Tax Chambers) has appeared for HMRC in an important test-case central aspects of the loan relationships code, in particular the “fairly represents” provision, and the proper treatment of exchange gains and losses.


Three companies in the Smith & Nephew group were in 2008 involved a restructuring which led to a change in functional currency from Sterling to US dollars. They had each since 2005 been owed large non interest bearing sterling balances by another group company: £1.63bn; £0.54bn; and £0.34bn. As part of the restructuring, the loans were paid off by the borrower company. Because of adverse movements in the Sterling/US Dollar exchange rate, the taxpayer companies’ accounts recognised losses of c675m, which the companies claimed to deduct for tax purposes.

HMRC refused the taxpayers’ claims for relief, arguing that the exchange movements recognised in the accounts following the change of functional currency did not give rise to allowable debits for the purposes of the loan relationship code, in particular because they did not satisfy the “fairly represent” criterion in section 84(1)(a) Finance Act 1996.


The Court of Appeal agreed with HMRC that the Upper Tribunal’s approach to the application of “fairly represents” was flawed, and gave new guidance. But on the facts, HMRC’S appeal against the Upper Tribunal’s decision in favour of the taxpayers failed.

  1. It was held by the majority that the Exchange Gains and Losses (Bringing into Account Gains or Losses) Regulations 2002 mandated the debits, and they were not subject to section 84(1)(a).
  2. If, contrary to that, section 84(1)(a) was applicable, then the losses nevertheless fairly represented exchange losses arising from the taxpayer companies’ loan relationships, and would still be deductible.